Economists downplay fears of financial crisis

When banks that are normally perceived as cash warehouses are caught in a credit crunch and there appears to be dim hope for an injection to quell the thirst for capital, it is hard for the market not to panic.

Thus, it seems natural that bank stocks fell out of favor with China's investors last Monday after the People's Bank of China (PBC), the country's central bank, published a hands-off response to the recent liquidity squeeze. Its warning letter railed against rapid credit expansion sowing trouble in the financial sector, although the PBC's urging of large banks to play their part helped interbank borrowing costs fall.

The PBC did show signs of relenting late Tuesday, issuing a statement which said it will offer liquidity assistance to cash-thirsty financial institutions that have been lending prudently in a move to belay fears of market turbulence. However, the central bank has maintained its stance to comply with Premier Li Keqiang's repeated calls for better use to be made of existing credit to support the real economy.

Rather than leading to an abrupt emergency, the situation engineered by the central bank would funnel excessive liquidity flows into runaway informal lending channels, pundits say. They further applauded this rare move made by Chinese policymakers, long used to shoveling cheap official funds into the market to feed cash-hungry banks.

Beating shadow lending

Banks that have been far too actively engaged in interbank lending as a main source of cash to keep their profits ticking over will face challenges in the wake of the incident, Jin Lin, a senior banking analyst with Orient Securities in Shanghai, told the Global Times on Wednesday. Jin pointed to the government's rising awareness of risk management in shadow finance.

The importance of deposit stability will grow in importance for banks, helping foster a sound, healthy banking system, Jin said.

For a long time, China's commercial banks have been playing a game against the central bank, especially with some getting so flexible with their money-lending that they forced the central bank to inject capital into the banking system, Guo Tianyong, director of the Research Center of China Banking at the Central University of Finance and Economics, wrote on his Weibo Wednesday.

Regarding the central bank's hands-off stance as a signal of its determination to steer credit into development of the real economy, Guo said this prudent monetary policy should continue.

The rise of trust funds and banks' wealth-management products (WMPs) beyond traditional bank loans in China is being seen as a mirror of the country's fast-growing shadow sector.

WMPs now account for 10 percent of total deposits in China's banking system, the Financial Times said in late February, pointing out that this has grown from virtually nothing in 2010.

Furthermore, according to estimates by JPMorgan Chase & Co, China's shadow lenders had almost doubled their outstanding loans between 2010 and 2012 to a total of 36 trillion yuan ($5.85 trillion), equivalent to nearly 70 percent of the nation's GDP.

In the 2013 China Financial Stability Report released on June 7, the PBC said China has no shadow banks based on international common definitions. However, some non-financial institutions engage in fundraising activities and some financial institutions carry out services characteristic of shadow banking.

But the market is divided over the severity of unintended consequences arising from the central bank's heavy-handed way of combating risks looming in the financial sector, especially regarding potential impact seeping out into the real economy.

"We expect this approach to be more effective and swift in slowing shadow activity than previous efforts," Fitch Ratings said in a statement released on June 21. It did warn that "such an approach also increases repayment risk among banks, and raises the potential for a policy mis-step and/or unintended consequences."